Jerome Powell was defiant and transient on Wednesday.

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No rate cut.

US Federal Reserve Chair Jerome Powell’s message to markets - low inflation is transient and will go back up.

OK, that’s it, block your nose and blow?

Maybe, maybe not.

After the Fed’s no rate cut call at Wednesday’s meeting, unemployment printed 3.6%, effectively signalling the lowest rate in nearly 50 years and indicating what appears to be a continuing strong economy in the US.


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But, will this lead to higher prices?

Not sure but with technology dropping the global cost curve (refer the Amazon Effect and similar theories) and with depositors, pensioners and seniors spending less money (because they have less, courtesy of QE infinity) perhaps the correlation between low unemployment and higher prices is fundamentally less strong than it was when the Phillips Curve was used as the central banker’s crystal ball.

More importantly, the 3.6% print supports the Fed’s position to hold (not cut) interest rates.

Politics and independence.

We keep on forgetting that whilst Donald Trump can jawbone down interest rates by personally attacking Fed bosses, the Fed can put pressure back on the President, and with 263,000 jobs added in April, Powell is probably feeling quite pleased with his defiance.

With both of the President’s men withdrawing their candidacy for the Fed, (Cain weeks ago and Moore this week) it looks like Powell might live (unchallenged) to defy the President again.

So, if Venezuela takes a back seat next week (hopefully civil war is averted), does this mean Trump will be out to get Powell again?

Will the Lion continue to roar at the Mongoose? Will the Mongoose back off or roar back, again?

Take home points.

Enough politics, here are some key notes I took from the Fed meeting:

  • Fed was unanimous in its ‘patient’ stance when considering adjustments, and with the data not pushing in either direction.

  • Eco growth and job creation stronger (note that this was also before the very strong unemployment numbers) and inflation weaker than expected.

  • Strongly committed to 2% symmetric inflation objective (Powell moved away from 2% asymmetric in January).

  • Tailwinds at the last meeting (slowing global growth, Trade, Brexit risks) have all moderated.

  • In March, the Fed decided to slow the balance sheet run-off (this means the Fed intends to stop draining its lake of free/easy money in September) and there was no change in view on overall run-off .

  • Whilst long-run maturity paper dominates the Fed’s balance sheet, Powell indicated no pressing need to resolve whether some of this is switched out for short-term paper and this will be looked at again at year end (potentially a tool to inject liquidity into the shorter end of the curve to the extent data warrants later in the year? Is this a short term put?).

  • Conclusion: No strong case to move either way. If inflation is seen to be persistently below 2% symmetric goal, the Fed will take this into account, but they can’t really see that happening.

Bloomberg asked a good question.

A Bloomberg staffer asked Powell whether he thought interest rates were already too low.

Instead of saying Yes, which is what I think Powell might have said had he not been Chair, he referenced the key tests the Fed uses to assess financial stability/vulnerability.

Powell stated that whilst the Fed felt some concern in relation to the non-financial corporate debt market (Janet Yellen has also been vocal about in recent times) overall members assessed vulnerabilities to be moderate and the financial system resilient.

Specifically, the Fed looks at 4 vulnerability/stability factors, namely:

  1. Asset prices - currently somewhat elevated with leverage in financial sector (but household defaults low and borrowing low).

  2. Non-financial corporates - currently some concerns mainly from highly leveraged business, but rather sees this as an amplifier for a downturn.

  3. Financial sector leverage - currently low.

  4. Funding risk – currently low.

We were told the Board will continue to take into consideration risks to the financial system.

Inflation, Phillips, trade and volcker.

Powell did state that the rate of underlying inflation (or expectations) and slack in the economy will continue to play a role in monetary policy setting but not to the extent they did in the 1960s when the Phillips curve was steep (i.e., read that to be responsive, as opposed to a flat curve now that doesn’t really seem to work when inflation continues to print low numbers at the same time as unemployment is falling).

However, the main market spooking comment that Powell made at the meeting was the Fed’s view that low inflation is transient, and will move back up, like it was for most of 2018.

He tempered this by stating that if inflation ran below 2% for a sustained period the Fed would take this into account. However, the Fed could not see this nor an overheating scenario at present.

Overall, Goldilocks can eat her pleasant porridge.

On whether or not a trade deal resolution would further stoke asset prices, Powell suggested that those who import metals or export product see the current uncertainty challenging, and whilst a resolution of trade would mean a more positive sentiment, economic gains are only likely to be felt over time, not straight away.

This was another example of Powell focusing his comments on economic effect as opposed to being drawn in to how the stock markets will respond, something he doesn’t feel is appropriate to comment on.

Finally, he would not be drawn on the status of changes to the Volcker rule, but did say he was reviewing comments.

Volcker is likely to be another battleground between the Lion and the Mongoose, particularly if debt related risks start to blip on the Fed’s radar.

And, with the US and global GDP approximately 318% geared (without taking derivatives into account), why aren’t they?

Mike.


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